Oil for Gold!

On January 18, 2004, Reuters reported that former Malaysian Prime Minister,
Mahatir Mohamed, advised Saudi Arabia to demand gold for its oil. For a couple
of days, the Internet was all abuzz about the statement, but nothing was written
to analyze in depth the possible ramifications of the Saudis actually making
that move.

That's probably because nobody thinks for a second that the Saudis might actually
do such a thing. But just imagine for a moment that Saudi Islamists stage a
coup and gain control of the Saudi's oil empire. Demanding that the US pay
gold for oil could indeed be their much-desired "weapon of mass destruction." It
would be the economic equivalent to setting off a neutron bomb in downtown
Manhattan.

In simple, straightforward economic terms, not even taking into account the
financial and political ripple-effect of such an action, it would eventually
force the world into either a quasi gold-standard, or a situation where only
specie is accepted in international trade.

It is, of course, no secret that Mahatir wants exactly that for his gold dinar.
The impact on the United States alone would be nothing short of devastating
- and that is without doubt is his intended result.

So, what's the immediate effect if OPEC "goes gold"?

The Effect:

For simplicity's sake, and to demonstrate just how brutal the effect would
be if Saudi Arabia took Mr. Mahatir up on this, let's for the moment disregard
the enormous upward-pressure on gold prices such an action would set off. Let's
take a look at the situation in terms of how long US gold supplies would last
if neither the gold nor oil prices were to change over the period in question.

According to the New York Fed, the US national gold stock is nearly 262 million
ounces (overlooking for the moment the possibility that the US no longer owns
much of its former gold). At the current market price near $405/oz, these ounces
represent slightly over $106 billion worth of gold buying-power.

It is hard to conceive a situation where, if the world's largest oil exporter
and holder of proven oil reserves should start demanding gold for its oil,
the other OPEC countries will not immediately follow suit. Other members would
not sit idly by and watch Saudi Arabia alone drain the world central banks'
gold reserves. They would most certainly want in on the action (and so would
Russia, Canada, and Mexico, as a matter fo fact). We therefore look at the
total US import figures from all of OPEC together (but excluding the other
major producers) in figuring out the immediate effect.

In 2003, daily US oil imports from OPEC countries averaged slightly in excess
of 5 million barrels a day, which amounts to 1.8 billion barrels per year.
At current market prices for crude oil (near $31/bbl at the time of this writing),
OPEC imports cost the US about $56 billion per year.

If the US had to pay for its OPEC oil in gold, it would have to ship about
138 million ounces of gold per year at current prices ($405 gold, and $31 per
barrel of oil). Since there are only 262 million ounces of gold (at best),
that means the entire US gold stock would be gone in a little under two years!

(As an aside, it is worth noting that the EU could outlast the US almost ten
times in that situation. EU imports just under one million barrels a day from
OPEC [one-fifth of US imports], and it roughly has a cumulative 384 million
ounces of gold reserves compared to the US' 262 million. That would give it
about twelve years of OPEC oil imports.)

Another US Invasion?

This kind of scenario will almost certainly cause the US to use its conveniently
positioned military to "intervene" in additional countries of the Middle East,
most likely Saudi Arabia and Iran, the number one and number three countries
in terms of proven reserves. (We've already got number two.)

But then again, the political capital may not be there to be spent on another
invasion. What would be the official excuse? "Just shut up, we need the oil?" I
don't think so.

If the need for immediate action is felt, however, just imagine that a small
suitcase nuke might go off in downtown LA, for example, and that such could
be publicly blamed on Iranian or Saudi terrorists. US public support for s
full-scale invasion of either country would be there in seconds.

If for whatever reason an invasion was not forthcoming, however, OPEC leaders
would have to do some really hard thinking on how to set the most effective
price levels of oil in terms of gold.

At current market prices, one ounce of gold (at $405 an ounce) buys 11.57
barrels of crude oil (at $35 per barrel), or 0.086 ounces of gold per barrel
of oil. Let's just say its close to a tenth of an ounce per barrel. In order
to make the transition a bit more palatable to the US and thereby avoid another
outright invasion, OPEC might set the gold price of crude at far lower levels,
say at 0.01 ounces per barrel. That way, the US could "live" on its gold stock
for almost 15 years or so. If OPEC were to single-mindedly and inflexibly pursued
an oil-for-gold policy, it would on the one hand certainly end up with all
of US gold stock in a very short time while, on the other hand, it would lose
its biggest customer. After the US spent all of its gold, there would be no
one left to fill the void.

Claiming Iraqi Oil

The US, of course, doesn't have to go the invasion route. It currently occupies
Iraq, which has the world's second largest proven oil reserves. If OPEC made
this policy change, the US could easily reverse its present course of turning
over government authority to the Iraqis, and could actually start behaving
like a full-fledged conqueror.

Iraq has 115 billion barrels of proven reserves. At a rate of 1.8 billion
barrels per year of oil imports from OPEC, the US can satisfy its entire current
OPEC import demand from Iraq alone for more than 50 years - once it brings
sufficient production capacity online. There are of course terrorist attacks
on pipelines, facilities, etc. to take into account. Nevertheless, it's better
than having to spend all of its gold on oil.

For the US, this would constitute the least expensive solution from a purely
economic cost/benefit standpoint. But this is where we need to consider the
inevitability of a gold price explosion that will result from the enormous
added demand from OPEC demanding gold for its oil. That price explosion alone
would immediately doom the dollar, and therefore the entire US economic machinery.

So, even if the US can avoid paying for oil with gold, which is not entirely
certain, (consider the political fallout from totally claiming Iraq) gold would
shoot so high as a result of the rest of OPEC demanding it that the dollar,
due to existing trade deficit/debt load problems, would be pulverized - ahead
of all the other fiats. Think, "US of A" as in "United States of Argentina"

Universal Gold-Settlement?

Whatever the complexities and strategic contingencies of such a move by OPEC,
one thing is immediately clear: If the oil consuming countries of the world
don't want to end up with dwindling buying power and disappearing public stocks
of gold, they'll be forced to demand gold settlement for all of their own exports
to OPEC countries. That, in turn would eventually cause the entire world economy
to get back to gold settlement, at the very least for international trade purposes.

The question arises: once most international trade is settled in gold (and
maybe silver, especially after its imminent price-adjustment) can individual
transactions within countries remain far behind?

What is "trade" between countries, really? Trade is not primarily something
the governments of different countries do with each other. Trade is mostly
conducted between different countries' private corporations and individuals.

So, if corporation "A" sells a shipment of Mercedes to a wholesaler in Saudi
Arabia, it can demand gold in payment. What will "A" do with that gold in its
home country? It may sell it for cash and use the cash to pay expenses, save,
invest, or buy whatever it needs. But in an economic environment where gold
is demanded by OPEC for oil payments, all paper currencies will rapidly depreciate
against gold due to an unbelievable increase in gold demand world wide.

Under that scenario, "A" would be worse than stupid to sell its ultimate value-retainer
- gold - for an ultimate value-loser - cash. So it will keep its gold. Corporation
B, which does business with "A" at home, sees its own "stash of cash" losing
purchasing power by the minute, so it wants gold, too. It will demand payment
in gold from "A" for its services.

In turn, A's and B's employees (at least upper management with enough clout)
may demand their pay in gold as well ... and so on, and so on. Maybe in the
US, legal tender laws and the abrogation of gold clauses will prevent such
a scenario, but there is probably little in other countries that would prevent
this from happening.

The more instances of this process take place, the more fiat would lose value,
in turn accelerating the entire process. Very soon, nobody will take cash for
anything except at tremendously discounted values, and everyone and their brother
will demand gold for literally everything. We will have a pure-specie currency
system in no time.

And that, dear reader, is Mahatir's plan. Could this actually happen?

Just ask yourself if the Wahabis could overthrow the Saudi dynasty, and you
have the answer staring you right in the face.

The "seeds" have been planted in the minds of OPEC leaders. If they grow,
their harvest will be in gold - and cash will be trash.

Just like driving your car, investing only makes sense
if you can see where you are going. The Euro vs Dollar Monitor is your golden
windshield wiper that removes the media's greasy film of financial misinformation
from your investment outlook. Don't drive your investment vehicle without it!